BUSINESS

FINANCE
CIA 1

SANKALP KASHYAP 1921450

SHASHANK BHARTI 19212456
SHIVANSH GARG 19212459
 EXECUTIVE SUMMARY

The optimum capital structure us the combination of equity and debt that leads to
the maximization of the value of firm. Thus, the capital structure decision is very
important to the firm, the optimum capital structure minimizes the firm’s overall
cost of capital and maximizes the value of the firm. The purpose of this report was
to calculate the value of the three following firms- Bosch, Motilal Oswal and DLF.
The method used to calculate the value of the firm are The Net Income Approach
and Net Operating Income Approach.

The Net Income Approach suggests that value of the firm can be increased by
decreasing the overall cost of capital through higher debt proportion. The Net
Operating Income Approach to capital structure believes that the value of a firm is
not affected by the change of debt component in the capital structure.

CAPITAL STRUCTURE: capital structure is defined as the amount of permanent

short -term debt,1 long-term debt, preferred stock, and common equity used to
finance a firm. In contrast, financial structure refers to the amount of total current
liabilities, long - term debt, preferred stock, and common equity used to finance a
firm. Thus, capital structure is part of the financial structure, representing the
permanent sources of the firm’s financing. This chapter deals only with the total
permanent sources of a firm’s financing; the decision about what proportions of
debt should be long -term and short-term is considered.
There are four capital structure theories:
1. Net income
2. Net operating income
3. Traditional approach
4. Modigliani & Miller approach (M&M)
In this activity we are going to talk about only Net income and Net Operating
Income
approach.
Net income: This approach was suggested by Durand and he was in favor of
financial leverage decision. According to NI approach a firm may increase the total
value of the firm by lowering its cost of capital. When cost of capital is lowest and
the value of the firm is greatest, we call it the optimum capital structure for the firm
and, at this point, the market price per share is maximised. The same is possible
continuously by lowering its cost of capital by the use of debt capital. In other
words, using more debt capital with a corresponding reduction in cost of capital, the
value of the firm will increase.
The same is possible only when:
1. Cost of Debt (Kd) is less than Cost of Equity (Ke)
2. If there are no taxes.
3. The use of debt does not change the risk perception of the investors since
the degree of leverage is increased to that extent.
Net operating income: This approach is also provided by Durand. It is opposite of
the Net Income Approach if there are no taxes. This approach says that the
weighted average cost of capital remains constant. It believes in the fact that the
market analyses a firm as a whole and discounts at a particular rate which has no
relation to debt-equity ratio. If tax information is given, it recommends that with an
increase in debt financing WACC reduces and value of the firm will start
increasing.

Companies:

DLF

DLF Ltd is engaged in the

business of colonization
and real estate
development. The
company operations span
all aspects of real estate development from the identification and acquisition of land
to planning execution construction and marketing of projects. It is also engaged in
the business of generation of power provision of maintenance services hospitality
and recreational activities life insurance and retail chain outlets. The company was
founded by Chaudhary Raghavendra Singh. The company developed some of the
first residential colonies in Delhi such as Krishna Nagar in East Delhi which was
completed in 1949.
Following the passage of the Delhi Development Act in 1957 the state assumed
control of real estate development activities in Delhi which resulted in restrictions
on private real estate colony development.
They therefore commenced acquiring land at relatively low cost outside the area
controlled by the Delhi Development Authority particularly in the district of
Gurgaon in the adjacent state of Haryana. Established in 1981 to manage
Singapore's foreign reserves GIC is a global longterm investor with well over
US$100 billion in assets in over 40 countries worldwide. During the year DLF
launched. DLF Ltd. DCCDL owns and operates a rent yielding portfolio of office
and retail assets of nearly 27 million square feet with significant further
development potential.

BALANCE SHEET OF DLF

Capital structure of DLF:

INCOME STATEMENT

Financial Report of DLF

 CALCULATION OF THE VALUE OF FIRM USING CAPITAL
STRUCTURE (NI AND NOI)

 Market value of Equity = Net income / cost of Equity × 100

= 22 ,790,000,000 / 10.25 × 100
= 22,234,146,3414.63
= 22,234.15 crores

 Market value of Debt = Interest / cost of debt × 100

= 5,903,100,000 / 10.3405 × 100
= 57087181470.915
= 5708.72 crores

 Value of Firm = Market value of equity + Market value of debt

= (22,234.15 + 5708.72) crore
= 27,942.87 crores

NET OPERATING INCOME APPROACH:

 NOI = Earning before interest and taxes / The weighted average cost
of capital
= 28,702,400,000 / 10.25 × 100
= 280023414634.14 = 28,002.34 crores
Working notes:

NET INCOME:
EBIT = 2870.24 crores
(-) Interest = 590.31
crores EBT =
2,279.93 crore

Cost of equity = Risk free Rate of return + Beta of Asset * (Expected

Return of the market - Risk free rate of return)

Cost of equity = 10.25%

Cost of debt = 10.3405%

 WACC = cost of equity × Equity weight + cost of debt × Debt weight

= 10.259304 × 0.642 + 10.304 × 0.432
= 10.24876
Approx. = 10.25

Analysis through capital structure: From the above calculation it is quite

clear that the value of the firm (V) will be increased if there is a
proportionate increase in debt capital but there will be a reduction in
overall cost of capital. So, Cost of Capital is increased and the value of the
firm is maximum if a firm uses 100% debt capital.
Motilal Oswal

Motilal Oswald is financial services firm offering a wide range of financial

products and services. It was setup by Motilal Oswal and Ramdeo Agarwal in
1987. The firm first started as a brokering house in 1987, after which it entered into
investment banking in 2005, followed by private equity in 2006.
Today it has become a multi-faceted financial services company with a presence in
over 550 cities through 2500+ business locations; ably managed by a team of over
6000 employees. Now it offers a diverse range of financial expertise works
synergistically to provide a host of products and services across Retail and
Institutional Broking, Private Wealth Management, Investment Banking, Private
Equity, Asset Management and Home Finance. All these businesses are
headquartered in a single location at Motilal Oswal Tower, Mumbai.
Currently it’s net worth is R.2764.14 crores and the company is headed by CEO
and managing director Navin Agarwal

Valuation of companies:
Net income Approach-
 EBIT = 323.34
(-) interest= (129.24)
EBT = 194.10
  Cost of Debt= 11.11%

 Cost of equity = Risk free Rate of return + Beta of Asset * (Expected Return
of the market - Risk free rate of return)

Cost of Equity = 9.03%

 Market value of debt = Interest / cost of debt × 100

=129/11.11%
= 1161.11 Lakhs
 Market Value of Equity= Net income / cost of Equity × 100
=194.10/9.03%
= 2149.50 Lakhs
 Market value of firm= market value of equity + Market value of debt
= 3310.61 Lakhs

Net operating income approach:

EBIT= Earnings before interest and taxes / The weighted average cost of capital
=323.34
WACC= cost of equity × Equity weight + cost of debt × Debt weight
= 10.07%
Value of firm= 323.34/10.07%
= 3210.92

Analysis: based on the above calculation, it was observed that the cost of debt is
higher than the cost of equity. Therefore, it advised to the business owner to
decrease the debt on the company and increase the equity to get better results.
Capital structure of Motilal Oswal

Balance sheet of Motilal Oswal

Profit and loss statement of Motilal Oswal
BOSCH Ltd.

In India, Bosch is a leading supplier of technology and services in the areas of

Mobility Solutions, Industrial Technology, Consumer Goods, and Energy and
Building Technology. Additionally, Bosch has in India the largest development
center outside Germany, for end-to-end engineering and technology solutions.
The Bosch Group operates in India through nine companies, viz, Bosch Limited,
Bosch Chassis Systems India Limited, Bosch Rexroth India Limited, Bosch
Engineering and Business Solutions Private Limited, Bosch Automotive
Electronics India Private Limited, Bosch Electrical Drives India Private Limited,
BSH Home Appliances Private Limited, ETAS Automotive India Private Ltd. and
Robert Bosch Automotive Steering India Pvt. Ltd.
In India, Bosch set-up its manufacturing operation in 1951, which has grown over
the years to include 15 manufacturing sites, and seven development and
application centers. Bosch Group in India employs over 30,000 associates and
generated consolidated revenue of about ₨.17,022 crores in 2015 of which ₨.
12,100 crores from third party. The Group in India has close to 14,000 research
and development associates.
FINANCIAL REPORT OF BOSCH Ltd.
CALCULATION OF THE VALUE OF FIRM USING CAPITAL
STRUCTURE (NI AND NOI)

NET INCOME:

 Market value of Equity = Net income / Cost of Equity × 100

=1301.5 / 11.89% X 100

=10,946.17 Cr

 Market value of Debt = Interest / Cost of debt × 100

=10.2 / 27.60% X 100
=36.95 Cr
  Value of Firm = Market value of equity + Market value of debt
= (10,946.17 + 36.95 ) Crores
=10,983.12 Cr

NET OPERATING INCOME APPROACH:

 NOI = (Earnings before interest and taxes / The weighted average cost
of capital) X 100
= (1646.60 / 18.2 %) X 100
=9,047.25 Cr

WORKING NOTES:

Weights:
a) weight of equity = E / (E + D) = 0.000 / (0.000 + 4.9565247718925) = 0
b) weight of debt = D / (E + D) = 4.9565247718925 / (0.000 + 4.9565247718925)
=1

Cost of Equity:
= 5.89000000% + 1 * 6% = 11.89%
Cost of Debt:
= 1.3682422915644 / 4.9565247718925 = 27.6049%.
Multiply by one minus Average Tax Rate:
The latest Two-year Average Tax Rate is 34.07%.
WACC= E / (E + D)*Cost of Equity +D / (E + D)*Cost of Debt*(1 - Tax Rate)
=0*11.89% +1*27.6049%*(1 - 34.07%)
=18.2%

Conclusion
The capital structure is the backbone and foundation for its financial development.
Since the capital structure directly effects valuation of the company, wealth of the
shareholder, the managers need to understand the implications of financial leverage
on the business. Therefore, the corporate management must use a thorough and
prudent procedure for establishing the target capital structure.

Typically, the cost of equity exceeds the cost of debt. The risk to shareholders is
greater than to lenders since payment on a debt is required by law regardless of a
company's profit margins.
For a company with a lot of debt, adding new debt will increase its risk of default,
the inability to meet its financial obligations. A higher default risk will increase the
cost of debt, as new lenders will ask for a premium to be paid for the higher default
risk.